Transcript Cargill Weather Risk Management Products

Cargill Risk Management
Weather Risk Management
for Agriculture
Michigan State University
March 22, 2002
© Cargill Incorporated 2002
Weather is a Business Risk
The U.S. Department of Commerce estimates that up to $1
trillion of the $7 trillion U.S. economy is subject to weather
risk.
Recent Weather Related News Items:
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…”Bullish hopes that a recent bout of hot and dry weather would hurt the
quality of the 2001 crops were thrown aside following reports of a rainy, cool
weekend in key corn and wheat growing regions…..” WSJ, May 22, 2001
•
…”Hot, dry weather in August damaged the nation's corn crop, dropping the
estimated harvest to the lowest in four years….” St. Louis Dispatch,
September 15, 2001
•
“Weather Problems Result in Bad Year for Michigan Wine Grape
Growers”….”even before the growing season began, more than half of the
buds of damage-prone wine grape varieties were killed by harsh winter
temperatures in December…..” Knight Ridder, October 20, 2001
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Weather is a Business Risk
That Can be Covered
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The market for weather risk management products was
established in late 1997 to help energy companies
hedge volumetric risk and smooth revenue streams. It
is quickly migrating to new industries as participants
become familiar with the applications and benefits of
these products.
Volume of transactions since market inception is
roughly $10 billion.
Weather risk management tools are used by
companies for protection against “adverse” weather
conditions.
Companies no longer have to bet on “good” weather.
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Weather Risk Management Products
Weather risk management products are structured as
customized financial instruments that allow companies to
hedge weather-related revenue or margin exposure.
 Protection generally for a season (winter/summer) or multiple seasons.
 Protection is typically based on an average weather index during a
season or on a specific weather event occurring during the season.
 Protection is typically capped to reduce cost.
 Protection can be tailored for a specific location or can be based on a
basket of multiple locations.
 Protection may be imbedded or combined with other risk management
tools or into physical commodity contracts.
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Weather Indices
 Temperature over period of time
 Temperature Extreme
 Rainfall
 Snowfall
 Snow cover
 River flow
 Wind speed
 Storm Activity (intensity, frequency)
 Misery Indices (wind chill, heat index)
 Frost/Freeze (if four hours below 28° then …)
 Combination/Multiple Triggers (if snow and temp then …)
 Customized Indices (multiple city baskets)
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Weather Risks for Crop Yields
1) Excessive heat - persistent temperatures above certain
thresholds are detrimental to crop.
2) Excessive cold – freeze/frost can harm planting and harvest.
3) Minimal precipitation - insufficient rainfall diminishes
crop size.
4) Excessive precipitation – too much rainfall diminishes crop
quality.
Poor Yields Equal Poor Revenues…………
Example -- For a 40 bu/ac drop in corn yield from expected:
$0.10/bu * 250,000 acre * 40 bu/ac = $1,000,000 deficit
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Yield (bu/ac)
Clinton, Eaton, Ingham Harvested Corn Yield (bu/ac)
160
140
120
100
80
60
40
20
0
1960
Year
1965
1970
1975
1980
1985
1990
Year
Weather Event
Time Period
Index
1996
1988
Early Wet
Early Dry
Hot
Dry
Dry
Dry
Dry
May-Jun
May-Jun
Jun-Aug
Jun-Jul
Aug
Jul
Jul
Rain
Rain
Extreme DD
Rain
Rain
Rain
Rain
1984
1976
1974
1965
1995
2000
Actual Average
11.88
0.83
343
2.96
0.58
1.21
0.5
6.41
6.41
72.5
6.31
3.22
2.62
2.62
• Extreme degree day = max(High Temp-86,0)
• Weather data from Lansing Station
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Weather Protection
Structure 1
Structure 2
Structure 3
Index
Rain
Extreme DD
Rain
Time Period
5/1-6/30
6/1-8/31
7/1-7/31
Threshold
3.5
inches
200
DDs
1.5
inches
10
cpb/inch
0.25
cpb/DDs
10
cpb/inch
25
cpb
25
cpb
25
cpb
Premium
2.1
cpb
1.8
3.75
cpb
Noted
Historical
Payouts
1988
1965
max
1/4 max
1988
1965
1989
max
1/2 max
2001
1/3 max
1978
1974
1967
1/3 max
1/3 max
1/3 max
Incremental
Payment
Maximum
Coverage
max
• Advantages
– Historical Payouts correlate well with low yield years
– Individual products are inexpensive
• Disadvantages
– Protection from all weather extremes has its cost
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Yield Protection
3 county average APH = 116.6
4 Levels of Coverage
Threshold
112
112
107
102
bu/ac
Incremental
payment
1.25
1
1.25
1.25
cpb/(bu/ac)
Maximum
Coverage
25
25
25
25
cpb
Premium
6.25
5.625
4.5
3.55
cpb
• Advantages
– Direct Volume Protection
• Disadvantages
– Cost is higher due to higher risk
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Daily Weather Indices
Lansing Precipitation and Temperature Indices
400
P1988
300
T1988 200
Index Value
500
P1982 100
0
T1982
P1996
-100
-200
T1996 -300
-400
115
Day of the Year
135
155
175
195
215
235
• Advantages
–
–
–
–
Flexibility in structure, cost, and timing
Can be traded like any financial index
Immediate settlement
Can protect against short term quality issues as well as seasonal volume
protection for specialty crops
• Disadvantages
– Developmental Stages….
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Cargill Risk Management
Contact us for more information:
Michael Grover, Mgr.
Weather Risk Products
952-984-3235
[email protected]
Ryan Williams, Ph.d.
Weather Risk Products
952-984-3680
[email protected]
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Quotes of the Day
“Everybody talks about the weather, but nobody does anything
about it.” (Charles Dudley Warner,1897, Hartford Courant)
“Drought is part of the cycle, but when it comes you’re never
ready for it.” (farmer of 33 years in Blue Springs, NE)
“We’re retailers, not meteorologists, and as long as weather
affects our business, we have to do something about it.”
(director of supply-chain strategy at Sears)
“I think the only thing we can do is pray for a very warm winter.”
(chief economist, Center for Global Energy Studies)
“For too long, businesses have cited bad weather as an excuse
for under-performance. This excuse is no longer valid.”
(anonymous)
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